The advent of stock screening software has made it possible for investors to search using any number of metrics, but that’s only part of building a successful investment portfolio. This complex process is the subject of an article by John Reese, founder of Validea Capital Management LLC., in the July issue of The American Association of Individual Investors Journal. Reese asserts that, while stock screening models are a helpful tool, they don’t provide all the information an investor needs.
Here is a summary of his guidelines:
- Choose a Screen You Believe in: With the myriad stock screens available, you should choose the one that “makes intuitive sense to you.” This will help you stick with your investment plan and endure inevitable performance fluctuations.
- Hold Enough Stocks to Maintain Diversification: An aggressive investor can hold 10 or 15 stocks, while a conservative investor should hold 30 to 50 shares. Reese also suggests building in liquidity requirements in the form of market cap and daily dollar volume minimums.
- Set a Maximum Level of Concentration: Maintain diversification through portfolio size as well as among industries or sectors.
- Break Ties by Ranking Stocks by Specific Criteria: When a screen makes stocks appear equally attractive, rank them by a variable that is important to you.
- When to Sell: This difficult and sometimes emotional question can be addressed through a regularly scheduled rebalancing system.
- Consider Tax Issues: Taxes can eat away a large portion of gains, so investors should use the tax system to their best advantage by considering short-term versus long-term gain consequences when establishing re-balancing time frames.
Reese concludes by reminding investors that creating a “real-life” portfolio forces investors into some gray areas that screening models don’t necessarily address. He writes, “Screens are a bit like your offense. They’re designed to go out into the investment world and get as many points as possible.” Portfolio management, he explains, “is more like defense against the market’s whims.”